On Political Books

May/ June 2013 Self-Made Countries

Why poor nations aren’t prisoners of their history.

By Charles Kenny

Turnaround: Third World Lessons for First World Growth
by Peter Blair Henry
Basic Books, 240 pp.


In his new book Turnaround: Third World Lessons for First World Growth, Peter Blair Henry, dean of the Stern School of Business at New York University, wants to persuade you of three big ideas about economic success in countries rich and poor. First, economies aren’t destined to wealth or poverty by constitutions or by bureaucratic structures; leaders have a choice to follow policies that lead to economic growth. Second, those policies involve both discipline and a sustained commitment to the future demonstrated by fiscal and monetary probity, open trade and financial regimes, and market-friendly policies. Third, says Henry, the stock market is a good guide as to which policies are “disciplined.” He is perhaps most persuasive on the first point, and least convincing on the third.

Turnaround is a book heavily focused on macroeconomic policy issues covering fiscal and monetary austerity along with the “Washington Consensus”—an oft-derided ten-point set of policy prescriptions for economies in crisis, so described by economist John Williamson because the criteria were recommended by D.C.-based organizations such as the International Monetary Fund, the Treasury Department, and the World Bank. As such, Turnaround is a welcome addition to a global development literature that has recently spent much of its time either discussing microeconomic issues at the one end—like the multi-award-winning Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty—and millennia-spanning work on the historical determinants of wealth like Why Nations Fail: The Origins of Power, Prosperity, and Poverty at the other. Besides providing a happy middle ground, Henry has produced one of a dwindling number of papers in the American Economic Review and can also be understood by readers who haven’t passed advanced classes in statistics and algebra.

Henry takes on institutional determinists’ view that economic policymaking and performance is largely preordained by a country’s past. He reprises his argument in the American Economic Review, noting that while Barbados and Jamaica shared very similar colonial histories, between 1960 and 2000 Barbados had per capita GDP growth of 2.2 percent compared to Jamaica’s 0.8 percent. Populist Jamaican politicians drove their economy into the ground while disciplined Bajan leaders kept their country on the straight and narrow through careful spending and controlled monetary and wage policies—a matter of choice rather than historical destiny.

There are other good reasons to think that Henry’s skepticism is justified. After all, North and South Korea and East and West Germany shared similar histories before they were torn apart—and have had dramatically different economic trajectories since. In the best-selling Why Nations Fail, authors Daron Acemoglu and James Robinson describe
China as an economy where growth will eventually hit a limit. Maybe so, but the quality of life enjoyed by the average Chinese citizen is much higher now than it was three decades ago, thanks in part to historically unprecedented economic growth over that time.

Nonetheless, while there’s bathwater to be thrown out, there’s still a baby in the institutional tub. Turnaround suggests that applying market interest rates, free exchange, openness to trade and finance, privatization, and liberalization in Latin America has lifted the region’s growth rates. Critics, Henry notes, will argue that the region still didn’t achieve growth rates anywhere near Asian miracle performance, but that “the germane comparison is not of Latin America to Asia, but of post-reform Latin America to itself before the onset of reform.” One is tempted to ask why. Might it be (pace Henry) that deep historical factors do at least somewhat constrain long-term growth rates in the region?

When it comes to policy choices, Henry is no market purist or purveyor of universal shock therapy. “Governments that adopt and maintain market-friendly reforms can deliver ongoing improvements to the material well-being of their people,” he notes, but in his view “market friendly” doesn’t necessarily mean the wholesale destruction of regulations. Nor does it require significant currency devaluation or budget cuts, except when they are forced by the depth of a country’s economic crisis. Henry suggests, for example, that the current eurozone penchant for fiscal compacts that demand huge budget cuts and tax increases is over the top. The IMF World Economic Outlook suggested late last year that if governments weren’t spending during this time of immense slack in the economy, they were just destroying growth. Christine Lagarde, managing director of the IMF, urged flexibility and restraint when it came to budget cutting last year, which Henry calls “eminently sensible.”

Turning to market-friendly policies, Henry dislikes the effort to create domestic industrialization using tariff barriers and subsidies. He suggests—rightly—that this tactic was a dismal failure across much of Latin America and Africa, and he fingers it as a cause of the 1980s debt crisis in those regions.

At the same time, in keeping with the moderate tone of his book, Henry notes that South Korea industrialized on the back of only partial liberalization. Economists including Dani Rodrik from Harvard and Ha-Joon Chang of Cambridge University go further, arguing that expanding the manufacturing base of a country, as South Korea did, is key to development despite the fact that it goes against free-trade norms. Once again, the truth probably lies somewhere in the messy middle, and “disciplined” industrial policy might be quite hard to identify in advance.

Indeed, given that some of the most successful countries in the world in terms of economic growth involve active government intervention in favor of cartels (e.g., South Korea) or where the government owned majority shares in large chunks of the economy from housing stock to airlines (Singapore) or where the country is still officially communist (China, Vietnam), it would be hard to argue that free markets are necessary—or even particularly effective—for development.

Still, in the end, it is often hard to argue too strongly with Henry’s thoughtful stances. Not least, there is surely a lot of truth in his contention that countries that engaged with the global economy rather than turning their back on it did better. Again, he concludes, “in debating the best method of promoting prosperity, we should not ask if the Washington Consensus worked or failed, but which elements from the menu of potential policies have worked in which contexts.” Policies surely do matter: maintaining broad openness to trade and finance while limiting government borrowing from banks and bond markets is a recipe for better performance, certainly on the margins.

Which is not to say that every stance Henry takes is similarly reasonable. The evidence he provides linking stronger stock market performance to future economic performance is, at the very least, weakly presented. While Turnaround does show that stock markets respond well to moderate reform programs, we don’t have to look too far from home to doubt the prognosticatory power of the exchange. After all, the S&P was at all-time highs in 2000 and approaching them again by 2007. Neither run-up presaged fair economic sailing ahead.

Charles Kenny is senior fellow at the Center for Global Development.

Comments

  • Hirron on May 29, 2013 9:17 PM:

    There is no "perfect" system of of economic management.

    America saw its success after shutting out British investment and creating a near instant turnover of wealth post revolution.


    Russia post revolution saw an economic boom in the first decade or so where the economy based on more or less informal measurements doubled-tripled in size, this is largely courtesy of large amounts of money dumped by government into industry, the more or less obvious kickback of this method was that money was obtained by selling off and taxing at high enough rates that many of their own people starved. This boom turned fizzle and went further on into stagnation

    China saw an economic boom when it reduced investment barriers, yet still has systems that prevent foreign takeover of Chinese firms

    Bangladesh still has yet to see an economic tide despite having nearly completely liberalized its policies

    Congo saw its economy collapse in the 80's after america finished using it as a springboard against the USSR

    South Korea, another american springboard saw a boom

    All of this is measured on GDP, which itself can be considered a flawed measure.

    Thailand has seen its economy boom after its fertility rate fell, India is seeing it boom because of its large population


    The truth is almost all legislation should be dynamic / sunset, there is no "correct" direction when you are talking about an interlocking system.


    Bringing this back to talking about how to develop countries the keystone is creating a pool of wealth concentrated in the purchasing of industrial machinery. that said

    . Entrenched holders may or may not want expansion and competition, why expand manufacturing when you can be rich off of local presence and monopolize
    - Change the hands of who owns it
    . revolution
    . loosening of international financing and reduction of protectionist measures forces competition
    - anti-monopolization laws

    . Detached foreign investments. If everything being done is done by hand your net result is that foreign investment are employers but not the developers of the economy

    - reduce anti-monopolization laws, allow for development of local tigers
    - subsidize local industry via tax revenue from international corporations
    - create greater incentives for locals to invest
    - put up minimum standards for foreign investment, draw a fine line between coming for cheap labour and coming to develop the economy and make a profit

    This is still taking in simplified views in that it pays no attention to cultural differences, economic global situations and so forth